The Net Investment Income Tax (NIIT), otherwise known as the ObamaCare Investment Tax, is imposed by the Internal Revenue Code section 1411, which applies a rate of 3.8% to the net investment income of trusts, estates and individuals who are earning more than the statutory threshold amounts. It went into effect on January 1, 2013, affecting income tax returns of trusts, estates and individuals beginning with their first tax year on the said date. However, it does not affect income tax returns that are filed in 2013 for the 2012 taxable year.
Individuals Who Are Subject to the ObamaCare Investment Tax
You are required to pay the tax if you have net investment income. The same goes if you have modified adjusted gross income over certain thresholds, such as $250,000 for married couples filing jointly, $125,000 for married couples filing separately, $200,000 for single individuals, $200,000 for heads of the family and $250,000 for qualifying widowers with independent children, of which amounts are not indexed for increase. To those who are exempt from Medicare taxes, they may still be obliged to pay NIIT based on these thresholds.
For the NIIT, the modified adjusted gross income is the adjusted gross income (AGI) increased by the difference between the amount excluded from gross income under section 911(a)(1) and the amount of any exclusions or deductions disallowed under section 911(d)(6) for the described amounts in section 911(a)(1). In case you are earning income from a controlled foreign corporation or a passive foreign investment company, you may have additional adjustments to your AGI.
On the other hand, you will not be subject to the NIIT if you are a non-resident alien (NRA) who is married to a US citizen or resident and is planning to make (or has already made) an election for the NIIT under sections 6013(g) and 6013(h) to be regarded as a resident alien who want to file jointly as married couple. You will be provided by the final regulations with special rules and a corresponding section 6013(g)/(h) NIIT election. Also, if you are a dual-resident individual within the meaning of the §301.7701(b)-7(a)(1) regulation, which determines that you are a resident of another country for tax purposes in conformance to an income tax treaty between that foreign country and the US, and are claiming the treaty’s benefits as a non-US resident, you will be regarded as an NRA for purposes of the NIIT. If you are a dual-status individual, who is an NRA for a part of the year and a US resident for another part of the year, you will be subject to the NIIT, but only with respect to the portion of the year where you are a US resident.
Trusts and Estates That Are Subject to the ObamaCare Investment Tax
Trusts and estates will be subject to the NIIT if they have undistributed net investment income and AGI that exceeds the threshold dollar amount at which the highest tax bracket for such entities starts for the taxable year under section 1(e), which is $11,950 for 2013 and $12,150 for 2014. Generally, these amounts are updated by the Internal Revenue Service (IRS) each fall in a revenue procedure.
Now, when will trusts and estates be exempt from the NIIT? They will not be subject to the tax if they are exempt from income taxes that are imposed by the Internal Revenue Code’s Subtitle A, which states the charitable remainder trusts that are exempt from tax under section 664 and the qualified retirement plan and charitable trusts that are exempt from tax under section 501. Other similar entities that are not subject to NIIT are: decedent’s estates or trusts of which unexpired interests are devoted to one or more of the resolutions that are described in section 170(c)(2)(B); those that are not classified as “trusts” for federal income tax purposes; those that are classified as “grantor trusts” under sections 671-679; perpetual care or cemetery trusts; and electing Alaska Native Settlement Trusts.
Inclusions in Net Investment Income
Generally, net investment income (NII) includes (but not limited to) dividends, interests, rental and royalty income, capital gains, non-qualified annuities, income from trading of financial instruments or commodities, and ventures that involve passive activities to the taxpayer. When calculating your NII, take note that it can be reduced by certain expenses that are properly allocable to the income. As for the common types of income that are not regarded as NII, they are wages, compensation for unemployment, operating income from a non-passive business, alimony, social security benefits, tax-exempt interest, self-employment income, distributions from certain qualified plans that are described in sections 401(a), 403(a), 403(b), 408, 408A or 457(b) and the Alaska Permanent Fund Dividends. Given that gains are not otherwise offset by capital losses, they will be included in the computation for NII, whether they are capital gain distributions from mutual funds, gains from the sale of mutual funds, stocks and bonds, gains from investment real estate sales, and gains from selling of interests in S corporations and partnerships to the extent that the shareholder or partner is a passive owner.
Application of the ObamaCare Investment Tax to Gaining on a Personal Residence Sale
The ObamaCare Investment Tax does not apply to any amount of gain that is not included in gross income for the purposes of regular income tax. According to the pre-existing statutory exclusion in section 121 of the law, the first $250,000 ($500,000 in the case of married couples) of gain that is recognized on a principal residence’s sale is excluded from gross income for the same purposes that are stated above, which means it is exempt from the NIIT.
Reporting and Paying for the Net Investment Income Tax
Trusts, estates and individuals are designated to use the Form 8960 and to follow specified instructions for the computation of their NIIT. Specifically, trusts and estates can report on their taxes and make the payment using the Form 1041, while it is the Form 1040 for individuals.